I have an encyclopedic knowledge of the complex tax code that has earned myself a national reputation as the tax attorney with whom industry insiders consult when they need help or a different perspective. During my more than 35 years as a tax attorney, I estimate that I've saved clients more than a billion dollars. Before heading into private practice, I spent eight years at the I.R.S. National Office in DC, helping to develop, interpret and apply the tax law. As a partner at SmolenPlevy in Vienna, VA, I work with clients on high-dollar tax issues, audits, estate and business planning.

2013 Federal Estate Tax: The .99% Versus The .01%

If you have been reading my articles, you should be aware of the bizarre application of the federal estate tax over the past twelve years. Depending on a person’s year of death estate tax liability could vary wildly from 0 to 55%, nothing to $10s of millions of dollars or more of estate tax liability. You would know that I am in favor of a repeal of the estate tax largely because, triggered only when wealthy people die (usually the death of a surviving spouse), it does not raise enough annual revenue to run the government for more than a few days. A nominal increase of the highest marginal income tax rate could more than make up for the lost estate tax revenue. You would also know that even without the federal estate tax, I am generally in favor of step-ups in basis to fair market value (in accordance with IRC Section 1014) because of difficulties income tax liability can cause regarding the disposition of estate assets, particularly when the remaining assets and liquidity available to a surviving spouse and descendents would be substantially reduced.

Under federal estate tax law for 2011 and 2012, most of the wealthiest 1% of American households are not subject to estate tax liability. This is because of the large estate tax exemption, presently at $5.12 million per spouse. This means that with nominal planning households worth less than $10.24 million could avoid the estate tax. Unless the law is changed the Federal estate tax is set to take another bizarre change in 2013. Generally, taxable estates over $1 million will be subject to estate tax, and the maximum marginal tax rate of 55% will begin at $3 million. However, these households may not get much sympathy from the ultra rich. In fact, the ultra rich may support a lower estate tax exemption in exchange for other concessions such as a lower maximum estate tax rate.

The ultra rich already have many wealth transfer tools to play with, most of which the IRS and Congress are fully aware. The ultra wealthy are much more likely to have substantially used grantor retained annuity trusts, charitable lead and remainder trusts, defective grantor trusts, dynasty trusts, family partnerships and valuation discounts to reduce or eliminate estate, gift and generation skipping transfer (GST) tax liability. I suspect that most of the super wealthy will have used their $5.12 million per spouse exemption for gift and GST purposes before the end of this year.

Contrast this with the plight (I understand there may not be much sympathy here) of the not as wealthy households with a net worth of $3, 5, 10 or maybe as high as $20 million. These households are more likely to need this wealth to sustain their standard of living. The wealth planning tools mentioned above are not used nearly as much because these households still need the assets to work for them or they are uncomfortable about the economic resilience they may give up. Planning is geared more towards making sure the estate tax exclusion for both spouses will be fully utilized, gifting up to the annual exclusion amount ($13,000 per donee, husband and wife can gift up to $26,000 per donee) each year, and paying for a descendents medical and education expenses. This level of wealth is also more likely to dissipate over one or two generations as it is passed down and divided up among multiple heirs and beneficiaries. A low estate tax exemption will certainly exacerbate this dissipation of wealth because of significant estate taxes paid.

Included in the top 1% are people who won the lottery and people born into wealth, another form of lottery. (I feel being born and living in the United States is like winning the lottery.) There are entrepreneurs and investors several of whom (Bill Gates, Warren Buffett, etc.) are quite notable. A relative few are entertainers and professional athletes. Doctors and lawyers are well represented in this group. A good number achieved their wealth by attaching themselves to a rising star – a notable company, person, product or idea. However, a good number achieved their wealth over a long period of time through hard work, investing/saving early and often, and managing what they spend. A low estate tax exemption would substantially curtail the accumulation of wealth by families on the lower end of the wealth ladder. If the estate tax is not repealed a fair balance could be a per spouse exemption of $3,500,000, with the maximum tax rate no greater than 35%.

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Just tax net wealth at 2% to raise 40% of federal taxes and eliminate the estate tax, gift tax and capital gains taxes and lower the income tax to 8%. A wealth tax serves as a negative reinforcer to investors by creating a “use it or loose it” incentive and the elimination of capital gains will create a “put up or shut up” business environment. The wealthy will have to earn their money.

The tax structure you propose is not likely to be adopted anytime soon. Your proposal is subject to the same reasons why a flat(er) income tax has not succeeded, plus a few more. I addressed some of this last September in my article Astronomy and the Federal Tax Law. Unless and until the system breaks, I feel we have to work incrementally within the tax structures we have. Recognizing that we have to work with the various interests people have, I have suggested changes that would require some sacrifices. Please see my October 2011 article, Managing Federal Deficits and the Federal Debt in a Flagging Economy: It Won’t Be Painless. I also recognize, and I believe you do as well, that the revenue system we maintain or establish is only part of the equation. We also need to bring spending and tax benefits (negative budgeting) in line with what we can afford. While I believe a balanced budget amendment is not necessary, annual federal deficits and federal debt should be limited (absent extraordinary circumstances) as a function of gross domestic product. Foregone revenue is only part of the reason why we accumulated such a large debt over the past twelve years.

While the tax base you propose can be a substantial source of revenue, I believe a wealth based tax for a country and economy our size would be difficult to administer. The difficulty starts with valuations. Unless you limit the tax base to cash and assets with readily ascertainable fair market values (which would substantially reduce the tax base), a wealth tax would substantially increase disputes over fair market value. Under current tax law there are already many disputes between taxpayers and the federal government regarding fair market value. These disputes are usually related to a taxable event under federal estate, gift and income tax law. With a wealth tax this can be all the time. In order to preserve the tax base and to administer the law equally among taxpayers, the government would be required to challenge more valuations. This would result in substantial administrative costs to the government. In addition to the cost to defend, the taxpayer would be faced with the uncertainty of what his tax liability is until a dispute is resolved or the statute of limitations has expired. Presently, the federal government is trying to get its arms around, for banking and income tax purposes, US taxpayer owned foreign accounts. Imagine how difficult the fair administering of a wealth base tax will be when substantially all foreign assets must be accounted for. Under our present system of withholdings and required payments, revenues flow to the federal government on an almost a daily basis. This too would be difficult to establish and administer under a wealth based tax system.

I respect your view that, “Unless and until the system breaks, I feel we have to work incrementally within the tax structures we have” but we apparently differ about whether the system is broken. The tax code has concentrated wealth to a point not seen since 1929. 60% of America live on only 3% of the countries assets. The top 10% are living well with 75% of the wealth ($45 trillion). Our extended economic malaise is not far from another recession or even depression. If new tax structures can solve the economic problems (and they can) we should not wait.

Business should supply about 20% of the tax revenue. Because 8 out of 10 businesses are no longer taxed as C corporations a value added tax (“VAT” – as used in every other developed country) is needed to equalize the different business rates and to lower the corporate rate. The combination of 8% corporate income tax and 4% VAT on business enables the elimination of all business tax loopholes, corrects the deferral of foreign corporate profits (by eliminating the 35% marginal rate) and would make American business the most competitive in the world.

For individuals, taxation based on both net wealth and income (in equal measure) is the middle ground of the political ideologies of the extreme left (supporting progressive wealth taxation) and the extreme right (supporting a regressive flat tax on income). The combination of 2% net wealth tax (excluding $15,000 cash and retirement funds) and 8% individual income creates a mathematically progressive rate structure. It is similar to the tax credits and escalating tax brackets of the current code except that it uses net wealth rather than hundreds of other types of tax expenditures (i.e. deductions, credits and “loopholes”) to raise or lower one’s tax liability.

This tax reform enables the elimination of regressive payroll taxes, and estate, gift and capital gains taxes which interfere with investment freedom. A typical family would save or spend $640 more per month; business would add jobs to meet the increased demand and owners would reap handsome profit by keeping 92% of income. The new economic ecosystem would be self sustaining, with no need for the government to borrow to finance (Democratic) government stimulus or (Republican) tax expenditures.

Your professional concern for wealth valuation is understandable but has been overcome by all other countries with a wealth tax and is now more manageable with universal access to internet databases. No person has identified a legal, logical or economic reason why this 2-4-8 Tax Blend would not produce sustainable economic recovery as promised.

There is no reason whatsoever for the American people or the tax code to make allowances for the desire of millionaires to maintain their standard of living in any way whatsoever except actively working for a living. If they can’t, then that’s just capitalism. If high estate taxes made sense to Andrew Carnegie and Teddy Roosevelt, they should make sense to any American.

While there are many ways, no doubt, to improve on the current complex tax code, there are powerful interests involved, all fearful of losing the benefits of the current code. Lawyers and accountants could lose their work, tax preparation and payroll service companies might lose their reason for existence, many wealthy people and countless companies could lose their lovely deductions and their relative freedom from taxes that strangle the poor and prevent the enrichment of the middle class.

So, while we might formulate a better tax system with relative ease, overcoming the powerful vested interests — most of whom have financed the election of individuals who will do their bidding — is virtually impossible.

Anyone giving serious thought to the matter will recognize that taxes serve to injure certain behaviors — as was observed as early as McCullough v. Madison (1819). Our current system is an attempt to grab money from people least able to defend themselves without much forethought, in its origins it was not an attempt to reward good and punish evil.

No one in their right mind and interested in benefitting society would tax exchanges between individuals or businesses. A tax on labor discourages employment and, more important, it discourages division of labor. We have become a nation of do-it-yourself, imitating impoverished North Korea to some extent. The tax on sales has the same effect.

Sales taxes sometimes penalize buying food, while real estate taxes penalize having shelter. What could be more senseless? Do we want people to starve and live on the streets?

The tax on real estate is, in effect, ownership of all property by government — a central tenet (or prediction) of The Communist Manifesto. We all rent from government(s).

The Communist Manifesto proposed a confiscation of all inheritance. The degree to which the rich have prevented this shows that despite the accuracy of Marx’s predictions (public schools, public control of transportation, etc), those with money have been able to protect their interests relatively well.

When we aim at increasing the wealth of everyone, a revolution in taxation will be required.

While there are many ways, no doubt, to improve on the current complex tax code, there are powerful interests involved, all fearful of losing the benefits of the current code. Lawyers and accountants could lose their work, tax preparation and payroll service companies might lose their reason for existence, many wealthy people and countless companies could lose their lovely deductions and their relative freedom from taxes that strangle the poor and prevent the enrichment of the middle class.

So, while we might formulate a better tax system with relative ease, overcoming the powerful vested interests — folks who have financed the election of individuals who will do their bidding — is virtually impossible.

Anyone giving serious thought to the matter will recognize that taxes serve to injure certain behaviors — as was observed as early as McCullough v. Madison (1819). Our current system seems to have been formulated to grab money from people in a hurry, in its origins it was not an attempt to reward good and punish evil, but in the end it has to a remarkable extent punished good and rewarded evil.

No one in their right mind and interested in benefitting society would tax exchanges between individuals or businesses. A tax on labor discourages employment and, more important, it discourages division of labor. We have become a nation of do-it-yourself, imitating impoverished North Korea to some extent. The tax on sales has the same effect.

Sales taxes sometimes penalize buying food, while real estate taxes penalize having shelter. What could be more senseless? Do we want people to starve and live on the streets?

The tax on real estate is, in effect, ownership of all property by government — a central tenet (or prediction) of The Communist Manifesto. We all rent from government(s).

The Communist Manifesto proposed a confiscation of all inheritance. The degree to which the rich have prevented this shows that despite the accuracy of Marx’s predictions (public schools, public control of transportation, etc), those with money have been able to protect their interests relatively well.

When we aim at increasing the wealth of everyone, a revolution in taxation will be required.

“Under federal estate tax law for 2011 and 2012, most of the wealthiest 1% of American households are not subject to estate tax liability. This is because of the large estate tax exemption, presently at $5.12 million per spouse. I suspect that most of the super wealthy will have used their $5.12 million per spouse exemption for gift and GST purposes before the end of this year.”

“Planning is geared more towards making sure the estate tax exclusion for both spouses will be fully utilized, gifting up to the annual exclusion amount ($13,000 per donee, husband and wife can gift up to $26,000 per donee) each year”

The two quotes above seem to be contradictory. If, in 2012, each person may give $5.12 million in gifts, without it (that $5.12 million) being subject to estate tax, why would there then be an estate tax exclusion (“annual exclusion amount”) of $13,000 per donee.

Say I give my son $5.12 million in 2012, then this $5.12 million would not be subject to estate tax. But since it’s only 1 son to whom I have given $5.12 million, the $13,000 per donee applies? meaning $5.12 million – $13,000 = $5,107,000 IS TAXABLE?